Saturday, October 01, 2016
The lessons of history - and don't expect a borrowing spree from Hammond
Posted by David Smith at 04:24 PM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

It may be the nature of the beast, but economic anniversaries tend to be unhappy ones. Fortyyearsago,Britainwas in the middle of one of the most humiliating episodes of the post war era, the bailout by the International Monetary Fund.

The IMF rescue,which came only three decades after Britain was instrumental in the creationof the organisation, is the stuff of legend. Denis Healey, the chancellor, had tried to spend his way out of recession. On his way to a finance ministers’ meeting in Hong Kong on September 28, 1976, he was forced to turn back at Heathrow to formally apply for the IMF loan.

It was an important time for economic policy in Britain. Three years before Margaret Thatcher came to power, theLabour prime minister James Callaghan signalled a shift away from the Keynesian consensusofthe postwar era,tellinghisparty conference that you can’t spendyourway out of recession.

That did not mean Labour was grateful for the IMF’s intervention. Healey, one of the great characters of British politics, looked forward to what he described as IMF “sod-off day”. He went to his grave last year believing the $3.9bn rescue was unnecessary.

That is not how it looked at the time but the numbers now suggest that the picture, while bad, was not as dramatically bad as we have experienced recently. In terms of the twin deficits — the budget deficit and the current account of the balance of payments — the situation in 1976 was that the budget deficit peaked at 6.4% of gross domestic product in 1975-6, while the current account was in the red by 0.9% of GDP, having peaked at 3.8% in 1974.

The recent peak in the budget deficit — public sector net borrowing — was much higher than during the IMF crisis,at 10.1% of GDP in 2009-10. The latest annual reading for the current account deficit, 5.4%, also exceeds anything in the 1970s. The deficit in the second quarter was 5.9% of GDP.

Those who ignore the errors of history are condemned to repeat them. I am not suggesting Britain is about to turn to the IMF for another bailout — it has other things on its plate—but if Labour has anything to do with it, we might at some stage take a trip down that particular memory lane.

Shadow chancellor John McDonnell managed in his party conference speech to both criticise the level of government debt, £1.6 trillion, and promise to add at least£250bn more to it than implied under government plans. After the mild tax and spend of Ed Miliband and Ed Balls in last year’s general election, we now have the full-blooded socialist version.

Fortunately, rather than being the “government in waiting” that McDonnell claimed his party was, Labour looks to be destined for opposition for many years to come. That, however, does not necessarily eliminate the risk. Political parties compete. McDonnell’s pledge ofa£10 an hournational living wagewas a ratcheting up of George Osborne’s policy, which implies a rate of just over £9 by 2020. When it comes to fiscal policy, there is also the possibility of competition. Though chancellor Philip Hammond will not take many of McDonnell’s ideas and run with them, an expectation is growing that his “reset” of fiscal policy will imply something significantly looser than his predecessor’s.I say expectation, because we are still pretty much in the dark on this, as we are about quite a lot from this government. There is talk of an end to austerity, as part of Theresa May’s attempt to reach the parts of society the recovery left behind. There is talk, more plausibly, of a new infrastructure drive, aimed particularly at the regions. With the government able to borrow over 10 years at a rate of 0.7%, what could be more sensible?

Let’s be clear. If the government could ring-fence a set of infrastructure projects and fund them at the current very low borrowing rates, it would make a lot of sense. Britain needs more and better infrastructure,and theeconomywill need the boost that it could bring. Reallife is,however,a bitmore complicated than that. Infrastructure projects are prone to delays and big cost overruns. The burden of those — and the risks — would staywith taxpayers and addtogovernment debt. This is why, so far at least, we have had a lot of talk of infrastructure bonds but very little action.

The assumptions of economic models, that infrastructure projects pay for themselves because of the boost they provide, can be elusive in practice. The widerpoint, when it comes to both austerity and infrastructure, is that the public finances are a long way from being fixed. Yanis Varoufakis, the former Greek finance minister, won last week’s pot-kettle-black award when he said on BBC radio that Osborne had been a“particularly inept”chancellor.

But Britain has addedalot of public sector debt in recent years—it has more thantripled fromjust over £500bn in April 2007 — and the deficit has been more stubborn than hoped. At 4.1% of GDP in 2015-16 it is smaller than it was when Britain had to turn to the IMF, but not that much smaller. Meanwhile, the Office for Budget Responsibility will surely confirm in the autumn statement on November 23 what bodies such as the Institute for Fiscal Studies have already told us. This is that while there are swings and roundabouts, including the help thatlower debt interest will provide, the net effect of Brexit will be to make the public finances worse.

What about those low interest rates? Surely any government would be foolish not to borrowwhenitis socheap to do so? Again, it is not as simple as that. Governments are not households, but sometimes the standard advice for households is useful.Do not assume interest rates will be this low for ever. Debt has to be rolled over, and in time it will be rolled over at higher rates than now.

All of which should mean that Hammond, whose instincts appear to be fiscally conservative, willnot take toomuch of a leaf out of his Labour opponent’s book. The aim, I judge, will be to keep the budget deficit on adownward track,while announcing some eye-catching but inexpensive initiatives. That will disappoint some, but it would demonstrate that at least one party has learnt the lessons of history.